Non-fungible tokens, or NFTs, have become one of the fastest-growing digital asset classes of 2021. According to DappRadar, NFT sales posted growth of over 700% in Q3 compared to the previous quarter, exceeding $10 billion in trading volume. Although this is still a fraction of the value locked in DeFi or the crypto markets overall, NFTs offer an intriguing opportunity for the digital asset space – true mainstream adoption. However, currently, NFTs are undergoing a rapid evolution in utility that will define the subsequent phases of their adoption.
NFTs emerged amid the frenzy of the last cryptocurrency bull run at the end of 2017. An early NFT craze, Cryptokitties, famously caused one of the first of many congestion incidents on the Ethereum blockchain. Despite the relatively frivolous use case, digital cats were a fun way to showcase the features of NFTs. Each Cryptokitty had unique attributes programmed into its code and can “breed” with other kitties to create cats with new characteristics. Those with the rarest or more desired features could command higher prices on the markets.
Art and Gaming – The First Use Cases
NFTs showed plenty of promise, particularly in the areas of digital art and gaming. Before NFTs, digital artists had no way to introduce scarcity to their work in the way that a physical artist produces an original copy. NFTs allow an artist to certify an original copy of a piece of digital art.
Over the last year, digital artists of all kinds have leaped on the opportunity to monetize their work, spurred on by headlines from across the art scene. Beeple’s $69 million sale via Christie’s drew global attention for being the first-ever sale of its kind – NFT-based digital art sold through one of the world’s oldest auction houses. However, it also catapulted Beeple into the position of the third-most valuable living artist in the world.
Gaming is also a segment that has a lot to gain from NFTs. Equipping gamers with a blockchain wallet allows them to own their in-game assets, even enabling assets to be portable between different games and creating market opportunities from secondary trading.
NFT gaming has seen impressive growth over the last year, with Axie Infinity a standout star. The blockchain game surpassed $2 billion in trading volume during September, becoming the first decentralized application to reach that number. It also passed the milestone of 1.5 million users in September.
A Shifting Landscape
As significant as the growth in these segments has been, we’re already seeing a shift in NFT utility as artists and brands realize the value of these assets as tools in building communities and driving engagement. For example, a digital artist called Odious opted to limit participants in a recent NFT drop auction to those who were already collectors that had supported his work – a fact that can be easily verified with a public blockchain address.
This move indicates a golden opportunity in NFTs – their ability to act as loyalty tokens that can also serve as verifiable tickets or passes to other events. For instance, imagine buying an NFT of an exclusive album drop from a favorite musician and the NFT also giving you access to front-row seats at a concert. Or a designer handbag purchase that comes with tickets to a fashion show.
Brands Are Waking Up
In a similar thread, brands are also exploring new ways to use NFT-based collectibles to generate engagement, loyalty and create new digital merchandise. In a version of the immensely popular McDonald’s Monopoly, Burger King has launched a similar promotion allowing customers to collect three NFT tokens via QR code when they buy a meal. Completing the set unlocks a fourth NFT which can be redeemed for physical rewards such as a free burger or digital bonuses, such as a promotional NFT collectible.
NFTs as digital merchandise, particularly in trading card games, is also gaining ground. Doctor Who: Worlds Apart is a trading card game featuring imagery licensed from the BBC, due to launch in full by the end of the year..
Another surprise entry to the NFT space comes from US toy giant MGA Entertainment, which recently launched a trading card game based on its collectible dolls, L.O.L. Surprise. The target audience is, intriguingly, young doll collectors who have almost zero pre-existing knowledge of blockchain or cryptocurrencies – but they do have a voracious sense of brand loyalty. MGA’s launch will be an interesting proof of concept for brands who may not have considered their audiences to be ready for NFTs.
All these developments are coming as many of the promised killer use cases for NFTs have still yet to be fully explored. Asset tokenization, fractionalized ownership, NFTs based on more valuable real-world property such as real estate, and the virtual metaverse, all throw up intriguing opportunities for mainstream utility and further adoption.
Challenges and Opportunities in NFTs
While there are plenty of exciting developments, the rapid pace of growth in NFTs is also throwing up challenges and opportunities for entrepreneurs. In particular, the “financialization” of NFTs is driven out of the need for better liquidity in secondary markets, along with the ability to earn returns on funds invested in NFT assets. In principle, each will help to drive the other.
The concept of NFT liquidity pools is inherently contradictory, as, by definition, a unique asset shouldn’t be easily exchangeable. However, platforms such as NFTX allow someone to use their NFTs as collateral to mint ERC20 tokens which make up specific funds based on subsets of NFTs. In aggregate, these tokens create fungible liquidity pools so that investors can trade in and out of certain NFT types.
Aavegotchi is another example, fusing NFT collectible with Aave’s DeFi aTokens, representing a loan or a debt on the platform. Aavegotchis are NFT-based digital pets akin to the 90s battery-operated Tamagotchi toys. Users keep their Aavegotchis alive by staking aTokens to them, effectively creating an interest-bearing NFT.
Innovations such as these are early attempts to address gaps in market infrastructure. However, in the meantime, NFTs markets remain decidedly volatile due to low liquidity and other issues such as a lack of price discovery mechanisms.
Finally, regulation is another challenge, depending on the jurisdiction. In some formats, particularly where they represent real-world assets, NFTs may fall under established securities trading laws. In Switzerland, the government has implemented a comprehensive regulation governing the issuance and trading of blockchain-based assets. The EU’s Markets in Cryptoassets Regulation may bring similar clarity across the bloc, but the details are yet to be defined.
NFTs represent a vast opportunity for the crypto space but also for various industries across multiple use cases. In just a short year of mainstream hype, we’re already seeing the landscape start to shift, and NFT utility move from the superficial to the tactical. Within a few short years, it seems feasible that NFTs could ultimately underpin the lion’s share of the value held on blockchains.